Signed, sealed and... not settled at all! Court of Appeal refuses to approve liquidators' entry into settlement deed

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By Nirupa Manoharan, Special Counsel, Jennifer O’Farrell, Senior Associate and Alden Ho, Associate

In the recent decision of McDermott and Potts as joint and several liquidators of Lonnex Pty Ltd (in Liq) [2019] VSCA 23, the Victorian Court of Appeal dismissed the liquidators’ appeal of the decision of the associate judge to refuse to settle a proceeding commenced by the liquidators.

Such directions are sometimes viewed as ‘easy’ to obtain with a perception that the Court will simply ‘rubber stamp’ any settlement reached by a liquidator. Lonnex roundly disapproves this idea, and emphasises that a Court will scrutinise whether, in all the circumstances, the decision to settle has been reached based on a proper foundation.

Background

Lonnex Pty Ltd (Lonnex) operated two medical practices. A related company, Millennium Management Pty Ltd (Millennium) operated another two separate medial practices. Both Lonnex and Millennium entered into separate agreements to sell all four clinics to Lonnex & Millennium Management Holdings Pty Ltd (LMMH) for the total sum of $40,000,000.

The transactions are alleged to have been phoenix transactions resulting in Lonnex and Millennium leaving behind substantial liabilities, including a significant debt to the Federal Commissioner of Taxation (Commissioner). Lonnex was wound up on the application of its members while Millennium was wound up by Court order. Separate liquidators were appointed to each company.

The Lonnex liquidators commenced various proceedings relating to the transactions which were funded by the Commissioner up to mediation. Following mediation, an offer to settle the Lonnex proceeding was made by LMMH which its liquidators were inclined to accept. The offer would have met their remuneration, costs and expenses and provide some return to creditors. A legal opinion was obtained by the liquidators and tendered to the Court to support their position that the settlement should proceed. However, the Commissioner rejected the approval of the settlement.

The Lonnex liquidators applied to Court under sections 477(2B) and 511 of the Corporations Act 2001 (Cth) (Act) for approval of the settlement.

Applicable Legislation

Section 511 of the Act enables the Court to sanction a course of conduct by a liquidator free from the risk of personal liability for breach if the Court is “persuaded that the liquidator’s decision to enter into the compromise is, in all the circumstances, a proper one”. [1] The Court noted that while section 511 was repealed and replaced by the Insolvency Law Reform Act 2016 (Cth) the replacement provisions (sections 90-15 and 90-20 of the Insolvency Practice Schedule (Corporations)) operated in a similar manner.

In contrast, section 477(2B) requires a liquidator to seek committee of inspection, creditor or Court approval for agreements entered into on a company’s behalf that may or will end after three months. In granting approval under this section, the proper approach to be adopted by Court is a balance having regard to, on the one hand, the commercial judgment of the liquidator and his or her knowledge of the circumstances of the liquidation and on the other hand the Court satisfying itself there is no error of law or ground for suspecting bad faith or impropriety.[2]

The Decision

At first instance, the Supreme Court of Victoria dismissed the Lonnex liquidators’ application. Associate Justice Efthim’s reasons included that all major creditors opposed the application. His Honour considered that creditors’ views were ‘extremely important’ in an application of this type.

The Court of Appeal also dismissed the appeal by the Lonnex liquidators. The Court outlined the following principles concerning directions under sections 477(2B) and 511 of the Act:

  1. The nature of inquiry undertaken by the Court under sections 477(2B) and 511 are different, in that:
    1. under section 511, the court must be positively persuaded that the liquidator’s decision to enter into the compromise is, in all the circumstances, a proper one. This involves broad consideration of all relevant circumstances. A direction will exonerate the liquidator;
    2. under section 477(2B), the Court reviews the liquidator’s proposal, satisfying itself that there is no error of law or ground for suspecting bad faith or impropriety, and weighing up whether there is any good reason to intervene. An order under section 477(2B) does not constitute an endorsement of the proposed compromise and will not exonerate the liquidator.
  2. Because the enquiry under section 511 is broader, a Court will usually consider this section first, as any consideration under that section would ‘substantially overtake’ any discrete consideration of section 477(2B).
  3. In respect of both sections 477(2B) and 511, the Court will pay due regard to the commercial judgment of the liquidator and the attitude of creditors. In this regard, the Court also noted that creditors are often better placed than a Court to judge their commercial interests.
  4. In respect of both sections 477(2B) and 511, it is ordinarily expected that a liquidator would have obtained appropriate legal advice in relation to the proposed compromise, and the nature and content of that advice is a relevant consideration.
  5. While the focus of section 477(2B) is delay, the inquiry still requires consideration of the substance of the proposed compromise. In particular, if a related application under section 511 shows that directions should not be given, then consideration of the application under section 477(2B) may be superfluous.

In considering the matter under section 511, the Court held that while the absence of funding for the Lonnex liquidators moving forward from the mediation was factor to be considered, it was not an overriding factor. Whilst there is no rule that once started, proceedings must continue irrespective of the availability of funds, a liquidator must consider all available options. In this case, a different compromise could have been reached, or the liquidators could resign and the proceeding be continued by Millennium’s liquidator (whom the Commissioner was willing to fund).
Like the Associate Judge, the Court of Appeal also considered that the views of Lonnex’s creditors were ‘highly influential’ (particularly in circumstances where those views were not irrational and unsupported by evidence), though they did not ‘dictate’ the Court’s decision.

The Court also held that the legal opinion proffered in support of the settlement failed to provide evidence that accepting the compromise was reasonable. While it is not the role of lawyers to assess the commercial reasonableness of a course of action, lawyers identify the strengths and weaknesses of a legal position and ascribe degrees of risk accordingly. Specifically, the legal opinion tendered by the liquidators did not address why the amount offered was reasonable or the overall strength of Lonnex’s claim. Whilst in another case this may not have mattered, in this case where an alternative course of action, advocated by the creditors and which one of them had indicated a preparedness to fund, it was important to determine whether the compromise was a proper one.

The Court held that even if the issue was considered under section 477(2B), it would have been refused as it would have been contrary to the interests of creditors given their views on the compromise.

Practical Guidance

Obtaining a Court direction approving a settlement is not simply a given. It must be supported by a proper foundation. Liquidators should notify and seek the views of creditors on the settlement and, if appropriate, obtain a legal opinion which supports their decision, having thoroughly assessed the strengths and weaknesses of the case.

Whilst Courts are ‘loathe’ to interfere with the commercial judgment of liquidators, the question of whether a settlement is ‘proper’ is influenced not only by commercial considerations, but by legal considerations. The Court will therefore give due regard to creditors’ wishes, legal opinion and alternative courses of action open to a liquidator.

If you have any questions, please feel free to contact Nirupa Manoharan or Jennifer O’Farrell.

[1] Re One.Tel (2014) 99 ACSR 247.

[2] Corporate Affairs Commission v ASC Timber Pty Ltd [1998] 29 ACSR 109.

For further information, please do not hesitate to contact us.

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